Sept. 14 (Bloomberg) -- Qantas Airways Ltd.’s bond risk
fell to a 3 1/2-month low as investors bet cooperation with
Emirates will pull the Australian airline back from the brink of
a junk credit rating.

Credit-default swaps that insure against non-payment on the
Sydney-based airline’s debt tumbled 55 basis points this month
to 357 basis points yesterday, set for the sharpest two-week
decline since October, CMA data show. The contracts cost 160
basis points less than the average for global peers on Sept. 10,
close to the widest advantage since June.

Qantas says the 10-year accord with Emirates on pricing,
sales, schedules and loyalty programs announced Sept. 6 can end
A$1.2 million ($1.3 million) a day in losses on international
routes. That’s boosting prospects the company can retain its
status alongside Southwest Airlines Co. as the only carrier
worldwide rated investment grade by both Standard & Poor’s and
Moody’s Investors Service.

“There was a risk they’d lose their investment grade,”
John Sorrell, head of credit at Tyndall Investment Management
Ltd. in Sydney, said by phone. “The deal doesn’t completely
rescue them but there’s a lot of positives to it. Probably the
Emirates deal will hold them in place for the moment.”

Breaking Even

The Emirates deal should allow the company’s international
unit to break even by 2015, Qantas Chief Executive Officer Alan
Joyce said Sept. 9.

The airline posted its first annual loss in at least 17
years last month as fuel costs climbed, demand from Europe
sagged and the strong Australian dollar hurt the nation’s
tourism industry.

The so-called Aussie, the world’s fifth-most traded
currency, bought $1.0575 as of 3:20 p.m. in Sydney, 42 percent
higher than the 20-year average of 74.5 U.S. cents. The Reserve
Bank of Australia has set the developed world’s highest
benchmark interest rates to manage a record mining boom, fueling
demand for the nation’s assets.

Cutting Losses

The Emirates deal will improve Qantas’s outlook by cutting
losses on European operations and renewing the airline’s ability
to expand in Asia, Qantas CEO Joyce said last week. He had told
an Australian parliamentary inquiry Feb. 6 that rating companies
may drop the airline to junk status if it can’t close the gap
between cash flow and capital spending, creating a “vicious
circle” as higher borrowing costs make it harder for the
carrier to upgrade its fleet.

About half of the A$1 million revenue Qantas typically
generates on flights between Australia and Europe is being eaten
up by fuel costs, Joyce said at an annual results briefing in
Sydney Aug. 23.

“The steps we have taken to transform our business and the
Emirates partnership position us to meet the goals of our
international turnaround plan,” Thomas Woodward, a Sydney-based
spokesman for the airline, said by e-mail Sept. 11. “The group
is well-placed.”

Qantas has a 65 percent market share in Australia, its
budget carrier Jetstar is the largest in the Asia-Pacific
region, and its loyalty program is the company’s most profitable
major unit with A$342 million of operating income in the 2011
financial year, the last period for which a breakdown is
available.

Interest Payments

Still, interest payments last year leapt 37 percent to
their highest level on record as net debt climbed to double its
level in 2008. Relative to earnings before interest, tax,
depreciation, and amortization, net debt is at its highest level
since 2006.

Qantas default swaps are more than 2 1/2 times as expensive
as for Southwest Airlines, which were at a seven-month low of
133 basis points yesterday. Contracts on Deutsche Lufthansa AG,
which Moody’s puts at junk, traded at 216.2, according to CMA,
which is owned by McGraw-Hill Cos. and compiles prices quoted by
dealers in the privately negotiated market. Moody’s rates Qantas
Baa3, its lowest investment grade.

The Markit iTraxx Australia index of credit-default swaps
that gauges perceptions of corporate bond risk declined 8 basis
points to 138 as of 10:24 a.m. in Sydney, Westpac Banking Corp.
prices show. The gauge is set for its lowest close since March
21, according to data provider CMA.

The extra return investors demand to hold corporate notes
in Australia instead of federal government securities fell to
218 basis points yesterday, the lowest in almost a year.

Yield Premiums

The yield premium on Qantas’ $513.6 million of 6.05 percent
bonds maturing in April 2016 shrank 65 basis points to 454 basis
points since reaching a record 519 on June 22, according to BNP
Paribas SA prices.

The spread on Southwest Airlines’ $300 million of 5.75
percent bonds due in December 2016 expanded 21 basis points to
208 in the same period, according to Trace, the bond-price
reporting system of the Financial Industry Regulatory Authority.

While the Australian carrier’s long-haul business was
facing “structural pressures” due to rising capacity,
competition, high fuel costs and a weak global economy, “we
expect Qantas’s earnings in its international operations to
improve” as a result of the Emirates alliance, May Zhong, a
Melbourne-based analyst for S&P, wrote in an opinion Sept. 7.

Qantas needs to have a more conservative outlook on
finance, Stephen Nash, a Sydney-based director at Fiig
Securities Ltd., said by phone.

Airline Bankruptcies

“Airlines generally have a habit of flying in and out of
Chapter 11,” he said, referring to a form of bankruptcy
proceedings under U.S. law. There have been 193 bankruptcies in
the U.S. airline sector since deregulation in 1979, according to
data from Airlines for America, an industry group.

While the Emirates deal was a “positive development,” it
may take some time for the benefits to be seen, S&P’s Zhong
wrote in last week’s report.

“We view the industry risk to be increasing significantly
in the Asian market due to intensifying competition,” she
wrote. “More and more Asian carriers-- who have much lower cost
bases -- have aggressively stepped up capacity to increase
market share.”

Dreamliners Scrapped

Qantas, which hasn’t proposed a full-year dividend since
2008, is also hanging onto cash by cutting spending plans.

The airline canceled a firm order for 35 Boeing Co. 787
Dreamliners worth about $8.5 billion at list prices and received
$433 million from Boeing, including more than $300 million in
compensation payments, as a result of delays.

Qantas also is pushing back until as late as 2021 eight
Airbus SAS A380s that were slated for delivery as soon as next
year, with only two due to be delivered before 2017. The
aircraft cost $390 million each, according to current list
prices.

Capital spending was A$2.13 billion in the year through
June, according to data compiled by Bloomberg, and the company
forecasts A$1.9 billion to be spent next year and again in 2014.

That compares to a February forecast of as much as A$2.5
billion this year and A$2.3 billion in 2013.

The Emirates deal “buys a lot of breathing space,” Fiig’s
Nash said. “It’s a very good choice for Qantas. Emirates are
well supported, they’ve got a great fleet, and it’s going to be
a hard combination to compete against.”